Wednesday, 13 January 2010

Legal systems and economic growth...

A recent article argues that the impact of legal systems on economic growth is not straightforward. While the two are related the precise effect of the legal system can change depending on the culture and political institutions of the country :

The “legal origins” project suggests that the lawmaking institutions are carried over from colonialism and thereby have an effect on economic outcomes many decades after independence. Evidence from this body of work suggests that “civil-law” countries have less efficient governments and courts, less secure investor rights, and stricter market regulation than “common law” countries (La Porta et al 2008).

Legal scholars, however, have recently documented a great wave of convergence of lawmaking institutions (Zweigert and Kötz 1998). This raises three questions.

Are lawmaking institutions really evolving?

If this is the case, what is the set of forces driving this evolution?

Can we still trust the “legal origins” project’s results?

Civil law and common law

The law and the lawmaking institutions are deeply influenced by two basic models: the civil law tradition and the common law tradition. While common law entrusts the lawmaking power to appeal court judges using a rule known as case law; civil law puts the legislative power in the hand of the government, the legislature or the president using a rule known as statute law. The impact of these two traditions is ubiquitous. Common law, which originated in medieval England, has been transplanted through colonisation into England’s ex-colonies. Civil law, which has its roots in the Roman Empire, was imposed by Napoleon to Continental countries and then exported via colonialism to many nations in Latin America, Africa and Asia.

New evidence

In a recent paper (Guerriero 2009), I argue against the legal origins project. Transplanted lawmaking institutions have in fact been changing over time and this wave of reforms reflects the welfare maximising choices of societies. In particular, building on data detailing the history of the legal order of 156 countries, I find evidence that pro-case-law reforms – in nations where “statute law” was imposed by colonisers – are more likely with a weaker democracy and a broader cultural heterogeneity. On the other hand, moves toward statute law in England’s ex-colonies are found where the cultural differences among subgroups are the smallest.

Culture is the main driver

Several recent psychological studies suggest that humans have well defined preferences over the harshness of punishment for dangerous actions, and that these tastes are influenced by the cultural biases of the group to which they belong (Herrmann et al 2008). From a theoretical point of view therefore, the socially optimal rule should be the mean of the rules preferred by each cultural group.

Under case law, appeal court judges weigh their own bias along with the cost of changing the precedent. Thus, opposing biases balance one another over time leading toward the optimal rule but at the cost of everlasting uncertainty. Under statute law, by contrast, legal rules are selected by a legislator – the government, legislature or president. The legislator weighs the welfare of society against the benefits obtained from favouring a cultural group, but chooses the socially optimal rule when no group is willing to offer a bribe.

When the disagreement among social groups is limited, the organisational cost that collective action requires will discourage bribing. In this case, statutes are both certain and optimal, and statute law outperforms case law.

But when the cultural heterogeneity is sufficiently high, statutes become more biased the lower the quality of the political process. A low quality political process places a low value of society’s welfare compared to that of special interests. In this case, it can be shown that case law prevails over statute law when political institutions are sufficiently weak.

While case law is the optimal law-making institution in relatively heterogeneous and/or less democratic societies, statute law should prevail where cultural tastes are sufficiently homogeneous in the population and/or society is sufficiently efficient in holding their representatives accountable. My research presents data in support of this prediction.

A “new legal origins” project

My findings cast several doubts on the broadly-advertised “legal origins” result that common law is more efficient than civil law. In particular, two main criticisms arise:

The legal institutions used to assess the impact of the “legal origins” of a country on her economic outcomes are wrongly codified and incorrectly assumed as fixed over time.

The determinants of the observed reforms are also driving the performance we want to explain; this makes the estimated effects unreliable.
Such failure is particularly concerning given that the World Bank is advertising the advances of the regulatory reforms identified as key by the “legal origins” project (World Bank 2009).

Clearly, creating focus on reforms chosen on the bases of unreliable estimates could result in ineffective or even harmful restructuring being implemented. On the upside, taking into full consideration the origins of institutional changes and the fact that their driving forces also affect the economic outcomes we are interested in can dramatically increase the economists’ ability to correctly inform policy design. This approach will also help us in understand if, in contrast to the incomplete markets theory (Coase 1960), the legal order as driven by legal institutions has no first-order effect on economic growth, investment, and financial development as claimed by Acemoglu and Johnson (2005).

Embarking in this “new legal origins” project constitutes a key endeavour for the economic profession. This is especially true now that the financial crisis has revived the political and social interest for the regulation of markets that had previously been left to the invisible hand.

No comments:

Post a Comment

All contributors should follow the basic principles of a productive dialogue: communicate their perspective, ask, comment, respond,and share information and knowledge, but do all this with a positive approach.

This is a friendly website. However, if you feel compelled to comment 'anonymously', you are strongly encouraged to state your location / adopt a unique nick name so that other commentators/readers do not confuse your comments with other individuals also commenting anonymously.

INVESTMENT OPPORTUNITIES

COPYRIGHT

DISCLAIMER

The Zambian Economist is a private website produced and maintained in my own time, and reflects solely my personal opinions. Statements published on the Zambian Economist do not represent the views or policies of employers, friends, family, past or present, or anyone I may or may not be associated with. Any view, opinion or information submitted in the comments section is the sole responsibility of the respective contributor or visitor to the site. These do not in any way represent the views of Zambian Economist nor can I be held responsible for them.